#$sm

SM Energy CEO Javan Ottoson is not willing to bet the round of corporate-level M&A that dealmakers are hoping for is on the horizon in the prolific Permian Basin.

By Tom Terrarosa

A relatively new player in west Texas' prolific Permian Basin had an unfortunate message for investment bankers Tuesday at IPAA's Oil & Gas Investment Symposia in New York: Sit tight, a long-awaited round of corporate consolidation in the Permian may be a long shot, at best.

Javan Ottoson, CEO of SM Energy Co. (SM), a Denver-based oil and gas exploration and production company that has effectively transformed itself over the past year into a Permian- and Eagle Ford Shale-focused operator, said somewhat reluctantly Tuesday while "all the bankers" like to hear that corporate-level consolidation among Permian strategics is the next logical step in the M&A cycle, he isn't willing to bet on it at this point.

"Everybody would desperately like to see some [corporate M&A] happen," he said. "It's easy in aggregate to say 'Wow, there's too many companies. Why don't they all get-together?' "

But SM's Ottoson said when you do the research and look at each company, you can easily determine that there are far fewer public targets in the basin than you'd think from taking a glance.

"Take us as an example. To pay for us, more than the market is paying for us; somebody's got to say, I can go faster than they're going. To get more value on our acreage, they have to say I can go faster than they're going," he opined. "I don't think anybody in their right mind can go a lot faster than we're going."

Not to mention the fact that everyone with the current multiples to support a multi-billion corporate level transaction is already in the Permian Basin, he said, adding that these players aren't looking to buy outside of the Permian in the current commodity environment.

So the Permian players aren't looking outward, and the majority of other U.S. shale players can't afford to buy in through a corporate level deal.

To be sure, as The Deal reported earlier this week, there are a few private acreage packages left for U.S. strategics to gobble up.

To name a few, Whitehorse Energy LLC has tapped Citigroup to shops its 80,000 net acres in the southern Delaware Basin. RBC Richardson Barr Securities Inc. and JPMorgan Securities LLC are marketing 60,000 net acres in the western Delaware Basin that belong to Three Rivers Operating Co. III, a Riverstone Holdings LLC company. And EnCap Investments LP-backed Felix Energy II has 55,000 acres in the eastern Midland Basin that could attract interest in the coming months.

But to justify paying upward of $50,000 per acre for an SM Energy, or one of the dozen or so other public Permian players currently trading at extremely heightened multiples, Ottoson implied Tuesday that you might have to either be crazy, a genius or both.

"You've got to know spacing. There's all these things that you need to know," he said. "And I think that's true for a lot of basins. There's just no argument that somebody with a big balance sheet can take this and go a lot faster. Because technically, it doesn't make sense."

Indeed, Stephens Inc. analyst Ben Wyatt said in an interview with The Deal on Monday, the first day of IPAA's conference, that he thinks there have to be some major setbacks for some these operators before any corporate consolidation can occur in the Permian.

"I think what you see over the next two or three-quarters is some guys execute and some guys stub their toe," Wyatt said. "When that happens, I wouldn't be surprised if you see some public, corporate M&A."

Because if it starts to become clear that some of these Permian operators won't hit the bold targets they're calling for in their 3-,5- and even 10-year plans, it may be easier for what Wyatt calls "the winners" to justify the thinking that they could execute better with the loser's mismanaged assets. 

At the moment, many of these future winners, or those that are betting on being winners like Parsley Energy Inc. (PE) and Diamondback Energy Co. (FANG), would likely tell you they're content with their recently bolstered portfolios.

But these toe-stubbing moments are exactly the type of catalyst that could cause a re-rating of many Permian operators, Wyatt suggested, bringing some heightened multiples way down and further supporting the thesis of corporate M&A.

That's when the industry follower suspects the Parsleys and the Diamondbacks of the world get bigger.

Until that day, though, SM's Ottoson isn't convinced.

"I'm sorry for all the bankers in the room who really want this to happen, but I just don't see it."

This alleged freeze of OPEC production seems to me like the final act of desperation on the part of these oil-producing countries to keep oil from breaking back below $40 on its own weight.

Think about it from their point of view. Once again, going into the OPEC meeting this week, we heard from the Saudis that they weren't going to cut back unless Iran cut back. Iran had been threatening to go from 3.6 million barrels a day up to 4 million with the addition of foreign capital.

The alleged deal -- and I say alleged because the Saudi oil minister Khalid al Falih specifically exempted Iran, as well as Nigeria and Libya, from the November agreement -- left the Saudis no choice but to cut back, or oil would most surely crater when these three intransigents got to their new levels. Remember, both Libya and Nigeria have seen their oil production cut by rebels.

You just need to do the math. Libya was producing 470,000 barrels per day two years ago. It had recently fallen to 292,000. Nigeria had been at 1.9 million barrels a day before the insurgents cut production to 1.4 million. The Iranians are at 3.6 million going to 4 million perhaps in a matter of months. So, OPEC was on target to produce about one million more barrels per day by year end than they did in August. So 33.2 million -- the current production -- was going to go to 34.2 million without some sort of a deal, which would most certainly have crushed the market.

Now, why do I think this deal is more talk than action, and why did oil only go to the $46 region on the deal announcement -- back to where it was before the most recent foray down to the low 40s?

Because if the oil production freeze beginning in November of 2016 is 32.5 to 33 million, and Iran, Libya and Nigeria have not agreed to freeze production, than who is going to cut back the minimum of 1.2 million barrels needed to get to the 33 million minimum target?

I don't think the Saudis will give up all that share. I don't see the Iraqis cutting back.

We haven't heard from the Russians who are going full out. The U.S. has stabilized at a production level that is 1 million barrels lower than its peak of 9.6 million -- and is about to go higher because of lower production costs.

So, the deal by itself is just chimerical. But, by saying it, OPEC managed to keep the price from plummeting -- as it was about to.

What could actually make the production freeze work? Higher demand.

It's in the interests of all producers to have oil higher. So they are going to keep up the talk.

But the physical market, where demand is stable to slightly weaker, is not going to comply without real cuts -- and we know that no country is talking about cutting production to the point that oil could get anywhere near the 33 million mark from the 34.2 million that OPEC was about to produce.

That's why I am calling it a desperate action to stop oil prices from collapsing again. They can't reveal the details because there are none.

So, don't get too excited. If you want to profit off it, go to the oil companies that have continued to lower their breakeven: Pioneer Natural Resources, EOG Resources, Apache, Parsley Energy, PDC Energy and SM Energy. They would be the beneficiaries of anything that keeps oil in the $40s, which this statement might have done.

But remember, by November we will know the target can't be hit without a big pickup in demand -- and once again crude will be fighting to stay above the $40 level, where production from the U.S. keeps coming back on line because of the 43% increase in rigs in the Permian since the country's rig-count low earlier this year.

Just when it seems like volumes cannot get any lighter, stock and options volumes hit new lows.  Yesterday was one of the lowest of the past year.

1.  C - Citigroup touched $52 for the first time since mid-January, as financials continued to lead the latest move higher.  Buyer of 13k of the Oct 55 calls for 0.38 in the morning.  That line ended up trading over 30k at an average price of 0.41 on the day.  C’s 52 week high is $55.28 from early January.

2.  JNS - Trader rolled a put position from Sept to Oct, selling 30k of the Sept 12 puts at 0.265, and buying 40k of the Oct 11 puts for 0.30 to open.  JNS has not traded below $11 since April.  The stock is down 1% year-to-date.

3.  LNG - Trader sold 8k of the Oct 75 calls at 5.30 to buy 14k of the Oct 80 calls for 2.875 to open, rolling a call position higher as LNG hit another new all-time high yesterday.  The stock is up 80% year-to-date, and there are still about 2x as many calls as puts outstanding in the options market.

4.  SM - Someone sold 20k of the Sept 75 puts at 0.30 to close, and bought 10k of the Oct 80 puts for 2.30 to open.  SM is up 2% year-to-date.

5.  DOW - Seller of around 4,426 of the Jan15 52.5 puts at 2.52 to buy 13,278 of the Jan15 57.5 calls for 0.84, traded midday.  A total of about 6,500 of the puts and 20,000 of the calls traded in total.  DOW’s all-time high is $56.75 from March 2005.  The next earnings report is in late October.

6.  PVH - Looks like another roll – the Sept 115 calls trade 16k at 6.40, and the Jan15 115 calls trade around 12k for 9.60, closing Sept and opening Jan15.  PVH is down 13% year-to-date, but the stock has rallied 10% from its early August low.

7.  TWTR - Stock closed at its highest level since March.  Calls traded nearly 3x more than puts, with the Sept 50 calls the most active line, trading around 14k at an average price of $0.88.  30 day implied volatility bounced to 37 after hitting a 1 year low of 35 last week.

Light volumes in options and the broader stock market after two active days to end last week.

1.  XLF - Calls very active as there was a seller of over 30k of the Jan15 20 calls at an average price of 2.50 in the afternoon, and some of that premium was likely used to buy over 60k of the Jan15 23 calls for an average price of 0.60.  XLF’s high of the year is $23.07, while the $21.86 level is both the spot of the rising 200 day moving average and the unchanged mark for 2014 for XLF.

2.  ABC - Bizarre trade in AmerisourceBergen, the pharmaceutical services company. The Aug16th 75 calls (expiring in 9 trading days) traded 40k at 2.325 in the morning, looks like they were bought to open, possibly delta neutral (a 1.65 million share print went up after the close), though not clear.  ABC options rarely trade at all, much less 40k at a clip, and moreover, that was for a very short-dated option with no clear catalyst.  ABC hit a new all-time high last week after a strong earnings report, and is up 10% year-to-date.

3.  XOM - XOM hit a new all-time high last Tuesday before falling to a 3 month low on Thursday on a poorly received earnings report and the overall market’s weakness.  The stock is now down 1% after the sharp fall.  There was a buyer of 15k of the Sept 105 calls for 0.40 to open in the afternoon.  XOM’s high last week was $104.76.

4.  SM - Trader rolled down protection, selling 10k of the Aug16th 80 puts at 2.50 to buy 15k of the Sept 75 puts for 2.10.  SM has not traded below $75 since early June.  The stock is down 3% year-to-date, despite the broad outperformance of the energy sector.

5.  ABX - Three way trade in October expiration – the Oct 18 puts trade 10k at 0.98, the Oct 18 calls trade 12,500 for 0.97, and the Oct 19 calls trade 20k for 0.5775, all around 1:42 pm EDT.  ABX is up 2% year-to-date, and has traded in the $15 to $21.50 range for the past year.